[Federal Register Volume 60, Number 132 (Tuesday, July 11, 1995)]
[Notices]
[Pages 35764-35766]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16919]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35927; File No. SR-NYSE-95-05]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to Near
Neighbor Approach to Measuring Specialist Performance
June 30, 1995.
I. Introduction
On February 28, 1995, the New York Stock Exchange, Inc. (``NYSE''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to adopt a new approach to
measuring specialist performance that would be used in allocation
decisions and modify an existing measure of specialist performance.
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 35661 (May 2, 1995), 60 FR 22593 (May 8,
1995). No comments were received on the proposal.
II. Description
The NYSE proposes to adopt, on a pilot basis, the near neighbor
measure of specialist performance to be considered by the Allocation
Committee in allocating stocks to specialist units.\3\ The Exchange
also proposes some modifications to its existing capital utilization
measure, which is currently used by the Allocation Committee on a pilot
basis.\4\
\3\ The Exchange's Allocation Policy and Procedures governs the
allocation of equity securities to NYSE specialist units. The
Allocation Committee has sole responsibility for the allocation of
securities to specialist units pursuant to Board-delegated
authority, and is overseen by the Quality of Markets Committee of
the Board of Directors. The Allocation Committee renders decisions
based upon the allocation criteria specified in the Allocation
Policy. The Allocation Policy states that the Allocation Committee
will base its allocation decisions on the Specialist Performance
Evaluation Questionnaire (``SPEQ''), objective performance measures,
and the Committee's expert professional judgment. See also note 13,
infra. The Allocation Committee currently considers the capital
utilization measure, in addition to several other objective
performance measures. See, e.g., Securities Exchange Act Release No.
35927 (June 30, 1995) (discussing NYSE Allocation Policy and
Procedures).
\4\ The specialist capital utilization program measures the
dollar value of a specialist's proprietary trading in relation to
the total dollar value of shares traded in the specialist's stocks.
The Commission approved the capital utilization measure on a one-
year pilot basis in Securities Exchange Act Release No. 33369
(December 23, 1993), 58 FR 69431 (December 30, 1993). The Commission
approved a six-month extension to the pilot program in Securities
Exchange Act Release No. 35175 (December 29, 1994), 60 FR 2167
(January 6, 1995) (extending pilot through June 30, 1995). The
Commission has extended the capital utilization program pilot so
that the Exchange and the Commission may evaluate the captital
utilization and near neighbor programs concurrently. See Securities
Exchange Act Release No. 35926 (June 30, 1995) (extending pilot
through September 10, 1996).
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The near neighbor measure compares the performance in a stock over
``rolling'' three-month periods to the performance of stocks with
similar trading characteristics (``near neighbors''). The near neighbor
program analyzes the following market quality measures: (1) Continuity,
which is the
[[Page 35765]]
change in price from trade to trade; \5\ (2) market depth, which is the
maximum price change over a 3000-share sequence of trades; \6\ (3)
quotation spread, which is the difference between the bid price and the
ask price; \7\ and (4) specialist capital utilization.\8\
\5\ Continuity is measured by the percentage of trades with a
change of \1/8\th point or less from the previous trade.
\6\ Depth is measured by the percentage of depth sequences with
a high/low range of \1/8\ point or less.
\7\ Spread is measured by the percentage of reported quotations
with a spread of \1/4\ point or less.
\8\ A capital utilization percentage is derived for each
specialist unit by dividing the average daily dollar value of the
unit's stabilizing purchases and sales by the average daily total
dollar value of shares traded in the unit's stocks. Capital
utilization is measured two ways: (1) using stabilizing dealer
volume; and (2) using stabilizing plus reliquifying dealer volume.
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Stocks will be separated into three broad categories: (1) Stocks in
the top 200 stocks in the S&P 500 Stock Index and other stocks that are
as active; (2) the remaining component stocks of the S&P 500 Index and
stocks among the 500 most active stocks on the Exchange; and (3) all
other stocks. The following stocks will be excluded from the near
neighbor analysis: Foreign stocks, preferred stocks, warrants, when
issued stocks, IPOs (for the first 60 days), closed-end funds, stocks
selling for $5 and under, stocks with less than 2,000 shares average
daily trading volume, stocks with two classes of shares, merger/
acquisition stocks if there was a significant impact on the price or
volume, and stocks that have been delisted for more than half of the
examination period.\9\
\9\ See letter from Daniel Pucker Odell, NYSE, to Katherine
Simmons, SEC, dated June 30, 1995 (excluding stocks that have been
delisted for more than half the examination.
Each month, each specialist units' eligible stocks are classified
as belonging to one of the three broad categories noted above. A
determination is then made for each individual stock (the ``target
stock'') as to which other stocks are statistically similar to it (its
``near neighbors''), based on certain market characteristics. The
characteristics that are used in this determination are price, non-
block volume, daily high low range, and the dollar value of the stock's
``float'' (i.e., shares that are available for trading that are not
closely held).\10\ A statistical formula is applied to each stock's
four market characteristics to determine its statistical ``distance''
from the target stock. Stocks with distances of 1.000 or less are
considered to be ``near neighbors'' of the target stock. Stocks with
distances greater than 1.000 are considered to be too different to be
considered ``near neighbors'' of the target stock.\11\
\10\ A stock will be considered ``similar'' to a target stock
if: (1) the median average daily price is within 30% of a target
stock under $20, or within $6 of a target stock between $20 and $60,
or within 10% of a target stock above $60; (2) the median daily non-
block volume (i.e., trades under 25,000 shares) is within 30% of the
target stock; (3) the median daily high-low range equals the median
high-low range of the target stock +/-7.5% of:
i. 30% of the price for a target stock under $20,
ii. $6 for a target stock between $20 and $60,
iii. 10% of the price for a target stock above $60 and (4) the
market value of the float is within 30% of the target stock.
\11\ If there are more than 20 stocks with distances of 1.000 or
less, only the 20 stocks that are closest to the target stock are
used in the analysis.
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For all stocks with three or more near neighbors, a single weighted
\12\ average performance percentage combining the results for all the
near neighbors is calculated for each market quality measure. Then,
using statistical techniques involving standard deviations, each target
stock's actual performance in the market quality measures listed above
is compared to the combined performance of its near neighbors.
\12\ The weight of a near neighbor stock decreases as its
distance from the target stock increases. If a stock's distance from
the target stock is less than 0.500, then its weight is 1.000. If a
stock's distance from the target stock is greater than 0.500, then
its weight is less than 1.000.
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When a comparison with its near neighbors is made, the target stock
is then placed into one of three groups: a stock whose performance is
statistically poorer than the mean performance of the near neighbor
stocks is classified in the ``Below Mean'' group; a stock whose
performance is statistically similar to the mean performance is
classified in the ``Mean'' group; and a stock whose performance is
statistically better than the mean is classified in the ``Above Mean''
group. Stocks that have fewer than three near neighbors are
automatically classified in the ``Mean'' group. An additional analysis
is performed on the stocks in the ``Mean'' group to highlight those
stocks that have relatively high performance even though that
performance is statistically similar to the calculated average of their
near neighbors. A ``Mean'' group stock will be considered to have
relatively high performance if its performance percentage is in the top
quartile of all stocks in its stock category (i.e., top 200, next 300,
or other).
Each specialist unit will receive three reports each month
containing the results of the near neighbor analyses for the most
recent three-month period. These will include: (1) A Stock Detail
Report for each stock that provides market data and performance
information about the stock and each of the other stocks that were
identified as its ``near neighbors,'' (2) a Stock Summary Report that
lists each stock and provides data on the performance of the target
stock and the average performance of its near neighbors, as well as
whether the target stock's performance is ``Below Mean,'' ``Mean,'' or
``Above Mean,'' for each performance measure, and (3) a Specialist Unit
Summary Report that shows, for each performance measure and within each
stock category, the number of stocks that are in each group
classification, and the percentage of the unit's total stocks that are
in each group classification. The Unit Summary Report also shows the
percentage of the unit's ``Mean'' group stocks that had high
performance percentages.
The Allocation Committee will receive only the summary data
appearing on the Specialist Unit Summary Report, which will be updated
each month (covering the three most recent months) upon the
distribution of the reports to the specialist units. The Allocation
Committee will not receive near neighbor performance data for
individual stocks. The Allocation Committee also will receive a list of
each unit's stocks that had fewer than three near neighbors and were
automatically classified in the ``Mean'' group. Included with each
stock will be its percentage of the unit's total dollar value of shares
traded.
The Exchange also is modifying the specialist capital utilization
performance measure to ensure commonality between it and the near
neighbor program as follows: (1) Exclusion of stocks with two classes
of shares (e.g., Class A & Class B), ``merger/acquisition'' stocks if
there was a significant impact on the price or volume, and stocks that
have been delisted for more than half of the examination period; and
(2) reduction of the performance review period for measuring capital
utilization from a rolling 12 months to a rolling three months.\13\
\13\ The Commission also has approved an NYSE proposal to reduce
the weight given in the allocation decision making process to the
Specialist Performance Evaluation Questionnaire from \1/3\ to \1/4\
in recognition of the Exchange's adoption for allocation decision
purposes of the near neighbor and capital utilization objective
measures. See Securities Exchange Act Release No. 35932 (June 30,
1995).
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III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder
[[Page 35766]]
applicable to a national securities exchange, and, in particular, with
the requirements of Section 6(b)(5) of the Act.\14\ Section 6(b)(5)
requires that the rules of an exchange be designed to promote just and
equitable principles of trade, to prevent fraudulent and manipulative
acts, and, in general, to protect investors and the public interest.
Further, the Commission finds that the proposal is consistent with
Section 11(b) of the Act \15\ and Rule 11b-1 thereunder,\16\ which
allow exchanges to promulgate rules relating to specialists to ensure
fair and orderly markets. For the reasons set forth below, the
Commission believes that the consideration of the near neighbor
analysis by the Allocation Committee should enhance the Exchange's
allocation process and encourage improved specialist performance,
consistent with the protection of investors and the public interest.
\14\ 15 U.S.C. 78f(b)(5) (1988).
\15\ 15 U.S.C. 78k(b) (1988).
\16\ 17 CFR 240.11b-1 (1994).
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Specialists play a crucial role in providing stability, liquidity
and continuity to the trading of securities. Among the obligations
imposed upon specialists by the Exchange, and by the Act and rules
thereunder, is the maintenance of fair and orderly markets in
designated securities.\17\ To ensure that specialists fulfill these
obligations, it is important that the Exchange develop objective
measures of specialist performance and prescribe stock allocation
procedures and policies that encourage specialists to strive for
optimal performance. The Commission supports the NYSE's effort to
develop the near neighbor measure to encourage improved specialist
performance and market quality.
\17\See, e.g., 17 CFR 240.11b-1 (1994); NYSE Rule 104.
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The Commission believes that the near neighbor measure should
provide the NYSE Allocation Committee with an objective measure of
specialist performance that will refine the Exchange's allocation
process. The NYSE's Allocation Policy emphasizes that the most
significant allocation criterion is specialist performance. In the
Commission's view, performance based stock allocations not only help to
ensure that stocks are allocated to specialists who will make the best
markets, but will provide an incentive for specialists to improve their
performance or maintain superior performance.
The Commission believes that the near neighbor measure, which
compares a specialist's performance in an issue to the performance of
other stocks with similar trading characteristics,\18\ has the
potential to be a significant advance in the NYSE's evaluation of a
specialist's market making. The near neighbor program analyzes four
market quality measures: continuity, market depth, quotation spread,
and capital utilization. The Commission believes these market quality
measures identify aspects of market making that are directly relevant
to the specialist's maintenance of fair and orderly markets. Thus, the
Commission believes that the near neighbor approach could aide the
Allocation Committee in allocating stocks to specialists who commit
their own capital to maintain stable and liquid markets.
\18\ The NYSE believes preliminarily that the stocks being
excluded from the near neighbor measure do not lend themselves to
comparison with other stocks and therefore could tend to
inappropriately affect the results obtained from the analysis. The
Commission therefore believes that it is appropriate that the
Exchange also exclude the securities from the capital utilization
program, which reports to the Allocation Committee a specialist
unit's commitment of capital relative to other specialist units. As
the NYSE gains experience with the near neighbor approach, it should
evaluate whether some categories of the excluded stocks can be
included in the programs in order to expand the universe of stocks
being examined via these approaches.
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Finally, the Commission believes that it is appropriate for the
NYSE to implement the near neighbor measure on a pilot basis until
September 10, 1996. A pilot will provide the Exchange and the
Commission with an opportunity to study the effects of the use of the
measure on the NYSE's allocation process. The Commission also has
approved an extension of the NYSE's specialist capital utilization
measure so that the two objective measures can be evaluated
simultaneously.\19\ During the pilot period, the Commission expects the
NYSE to monitor carefully the effects of the near neighbor and capital
utilization programs and report its findings to the Commission.
Specifically, the Commission requests that the NYSE report the near
neighbor and capital utilization data as presented to the Allocation
Committee. In addition, the Exchange should, for a three month sample
period,\20\ submit a report that identifies the specialist units, the
securities for which they applied, the stocks that were allocated to
them, and the specialist units' SPEQ ratings as presented to the
Allocation Committee.\21\ In the report, the Exchange should identify
allocations that were made to specialist units with relatively poor
tier ratings in the objective measures and discuss the reasons the
Allocation Committee made such allocations.\22\ Because near neighbor
also measures, among other things, capital utilization, the Exchange
also should address in its report how the two measures work together
and whether there is a need for a separate capital utilization standard
if they determine to continue the near neighbor measure.
\19\ See supra note 4. The Commission recently extended the
Exchange's Rule 103A pilot program so that it would run concurrently
with the near neighbor and capital utilization pilot programs. See
Securities Exchange Act Release No. 35704 (May 10, 1995), 60 FR
26060 (May 16, 1995). Rule 103A grants authority to the Exchange's
Market Performance Committee to develop and administer systems and
procedures, including the determination of appropriate standards and
measurements of performance, designed to measure specialist
performance and market quality on a periodic basis to determine
whether or not particular specialist units need to take actions to
improve their performance. The Commission emphasized in the
extension order its belief that objective measures of specialist
performance should be incorporated into the evaluation process.
During the pilot period, the Market Performance Committee will
receive quarterly reports on the near neighbor initiative, with a
view toward their recommending such enhancements or modifications as
may seem appropriate based on actual experience with the measure.
The Commission believes that the Exchange should have sufficient
experience with the capital utilization and near neighbor measures
of specialist performance at the end of the pilot period to judge
whether these objective measures should be incorporated into the
Rule 103A evaluation criteria.
\20\ This sample period shall be January 1, 1996, through March
31, 1996.
\21\ The Commission believes that this information will allow it
to evaluate to the extent to which the Allocation Committee's
decisions appear consistent with the relative performance of
specialist units according to the objective measures. In this
regard, however, the Commission recognizes that the Allocation
Committee also considers the SPEQ results and may use its
professional judgment in making allocation decisions. See supra note
12.
\22\ The Exchange may submit one report for both the near
neighbor and capital utilization pilots. This report should be
submitted to the Commission by May 15, 1996, along with the
Exchange's request for permanent approval or extension of the pilot
programs.
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\23\ that the proposed rule change (SR-NYSE-95-05) is approved
through September 10, 1996.
\23\ 15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\24\
\24\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 95-16919 Filed 7-10-95; 8:45 am]
BILLING CODE 8010-01-M